Today I wish to challenge a piece of economic orthodoxy which is that lower prices are bad for us. In essence the narrative goes like this. A rational consumer observing lower prices would delay his or her purchases until the relevant goods or services were cheaper and thus better value. However if we raise such behaviour from the individual or micro level to the macro or aggregate one the move to lower prices would involve a fall in aggregate demand in an economy as individuals delayed their purchases. This matters right now as more and more places are not only seeing lower inflation but actual price falls, for example today has already seen an annual inflation rate of -0.3% in the region of Saxony in Germany.
How did we get to such a conclusion?
This has been reinforced by the behaviour of central bankers who have pushed the theme that low inflation is good for us. Indeed as the excerpt below shows they have even perverted the meaning of basic words to do so. From the European Central Bank.
The ECB’s Governing Council has defined price stability as “a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%. Price stability is to be maintained over the medium term”.
They go further and tell us that a benefit of their “price stability” is this.
improving the transparency of the price mechanism. Under price stability people can recognise changes in relative prices (i.e. prices between different goods), without being confused by changes in the overall price level
Actually that would be easiest if inflation was 0% wouldn’t it?! In such a situation all price changes would be relative ones and they would be extremely transparent. Plainly price stability would involve 0% inflation and if that had been the plan all along then there would be less panic in the Euro area right now. Of course rather than that we have seen suggestions from parts of the IMF amongst others that the inflation rate target should be 4% in a rather transparent effort to apply some not very stealth like inflation to debt burdens.
What about electrical goods?
These has been a clash between theory and reality for some time here. After all if we were the rational consumers of the theoretical world none of us would have a television,laptop,tablet or smartphone. I would not be typing this now as I would be waiting for a cheaper opportunity to buy a PC. Yet we know the world is full of the latter particularly which could not have had more of a boom. Look at this from the results of Apple’s latest quarter.
The results were fueled by all-time record revenue from iPhone® and Mac® sales as well as record performance of the App Store℠. iPhone unit sales of 74.5 million also set a new record.
Actually we are in fact left wondering about the opposite effect where price falls especially when combined with technological innovation actually lead to a rise in demand.
Retail Sales make the case
This morning has seen this release from the Spanish statistics institute.
The annual rate of the General Retail Trade Index at constant prices stands at 6.5% in the series adjusted for seasonal and calendar effects and at 5.4% in the original series.
Quite a blast higher isn’t it but shouldn’t Spanish consumers be waiting for cheaper prices?
The Harmonised Index of Consumer Prices (HICP) annual change stands at –1.1%, showing a decrease of six tenths as compared to November.
Now whilst December may have been something of a freak or outlier we can say that as Spanish prices have begun to fall as they did in the latter part of 2014 then it has been accompanied by a rise in retail sales overall as opposed to the fall that economics 101 predicts.
If we travel across the Irish sea to the Emerald Isle we see something similar. Yesterday’s release from the Central Statistical Office again reported very strong retail sales.
The volume of retail sales (i.e. excluding price effects) increased by 0.5% in December 2014 when compared with November 2014 and there was an increase of 5.1% in the annual figure.
This has been combined with disinflationary pressure and now outright falls in the prices that consumers pay.
Prices on average, as measured by the EU Harmonised Index of Consumer Prices (HICP), decreased by 0.3% compared with December 2013……The HICP decreased by 0.4% in the month.
Indeed if we look at the retail sales data we see that much of the recent improvement has been caused by falling prices. The annual increase in the value of retail sales was 2.8% in December compared to a volume increase of 5.1% with the difference being lower prices.
Earlier this month the evidence from the UK was both clear and stark.
In December 2014, the quantity bought in the retail industry (volume) increased by 4.3% compared with December 2013. The amount spent (value) increased by 1.9%. In December 2014, nonseasonally adjusted data show that the prices of goods sold in the retail industry (as measured by the implied price deflator) decreased by 2.2%.
Unlike UK consumer inflation which was still positive in annual terms (0.5%) in December prices in the retail sector have fallen. This has been accompanied by something of a surge in retail sales volumes. Indeed as shown below the retail sales surge has been very powerful.
The underlying pattern in the data as suggested by the three-month on three-month movement in the quantity bought continued to show growth for the 22nd consecutive month increasing by 2.3% and was the strongest growth since April 2002 when it was 2.5%. This was the longest period of sustained growth since November 2007…..
Indeed the idea that inflation is somehow good for us is challenged again by this from the same report. Look what happened when we were in the situation of inflationary pressure which the Bank of England has lauded.
Between January 2008 and January 2013, the area shaded in grey, the volume of retail sales was broadly flat while the value of retail sales continued to grow, increasing by 12.1%.
There is a cautionary note to this and it is that in any economy we cannot undertake a test-tube style experiment as we observe many things happening in the same time frame. However if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly. If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.
Not every economy has seen a boom accompany falling prices as Greece again comes to mind. However a sustained fall in the price level has been accompanied now by signs of a retail pick-up so are we seeing a positive effect there too? Of all places the mess that is the Greek situation makes the issue foggy and muddy but this is so far away from conventional and official thought it has a solid chance of being true. In musical terms my message to conventional economics comes from the first album I ever bought so cue Stevie Wonder.
They’ve been spending most their lives
Living in a pastime paradise
They’ve been spending most their lives
Living in a pastime paradise
They’ve been wasting most their lives
Glorifying days long gone behind
They’ve been wasting most their days
In remembrance of ignorance oldest praise
Tell me who of them will come to be
How many of them are you and me